Apart from liquidity, what else do Exchange Traded Funds (ETFs) offer pension schemes? A lot, argue providers - as long as they can get them accepted by some consultants
Long thought of as a more retail-focussed product, the institutional investing world has begun to embrace ETFs in both a direct and more indirect way, driving up demand for the low cost passive index tracking vehicles.
ETFs affect pension schemes in two ways, firstly they enable self-directed schemes to invest directly in new asset classes that would normally be ignored. With larger mandates for active managers, schemes can end up being invested in ETFs as their manager looks for flexibility and a quick route into a market.
"With ETFs, managers have to spend less time on individual, unnecessary, stock picking," says Scott Thomson, co-head of European sales at ETF Securities.
"Pension fund mandates have become much more flexible and scheme or fund managers spend much more time getting their allocations right," he says. "If they are diversifying into, for example, alternative assets or real assets, they tend to spend much more time on that than on individual stock checking. Managers that handle a scheme's money increase the use of ETFs as passive big building blocks to build up their overall allocation."
With their easy access, they are proving to be a growing part of a fund manager's toolkit, explains Thomson.
Claus Hein, head of Lyxor ETFs UK & Nordics, says that he has seen a significant increase in pension schemes using ETFs across a number of investment strategies. "They can provide effective access to multiple markets and asset classes and (gain) beta returns in a low cost manner," he says. .
ETFs, of course, can be taken out on almost anything, almost anywhere. Pension schemes use the vehicles to get exposure to difficult to reach markets, such as emerging markets, which can be difficult or expensive to access through a direct route.
"We have seen numerous pension schemes embracing ETFs for emerging market allocation and actually on a regional and a country specific basis. They are used mostly for difficult to reach geographical areas, to get that global exposure many now seek," says Hein.
What's more, ETFs can be traded directly via brokers and dealers or specialised ETF authorised participants throughout market hours, and investors do not need any additional documentation to hold or trade ETFs in their portfolio. "From an administrative perspective this also is a beneft," adds Hein.
Getting the message across
Roel Thijssen, managing director at Blackrock and head of iShares Benelux & Middle East, says that there has been an increase of European institutional investors using ETFs in the last couple of years, but their full potential in a large portfolio is still to be realised.
One reason for this, certainly in the UK, is that consultants have not always been willing to take them too seriously. In mainland Europe and America ETFs are more commonly used, says Thomson.
"On the continent ETFs are used more because the market is not so tightly controlled by consultants," he says.
"We are beginning to see the European pension schemes starting to make their own direct investments in ETFs. In the UK it is more the smaller to medium sized pension funds trustees who aren't as tightly affiliated with consultants (who have shown interest)."
Thijssen says that consultants do not all have the knowledge, or feel comfortable using ETFs.
"But they should," he says, "they need to know about innovative developments in the sector and ETFs are such an innovative development. They need to be aware of it; the market is worth over a trillion Euros currently. You can't deny their existence anymore. If they do, then they are probably not giving their pension fund clients the best advice."
Nevertheless, ETFs are being used in the UK, says Thomson, naming councils and the large Railways Pension Scheme, with its in-house investing team, as an example.
"We see the bigger schemes using ETFs to complement existing actively manage strategies and to complement their overall portfolio holdings with a tactical position in a specific market. We also see smaller schemes that use ETFs to make individual decisions themselves. In particular funds that have in-house trading operations and are more set up to make and implement their own decisions welcome ETFs."
Thijssen argues that ETFs have other benefits that can become apparent the more they are used. Long-term, he says, they can give a pension scheme exposure to hard-to-access markets. Short-term, they can provide exposure to an asset class immediately and cover a gap in the event that a scheme is in the process of hiring or searching for, a manager.
"It's an immediate solution and as we have experienced an attractive feature of ETFs for schemes," he explains.
"Some schemes have both long and short-term ETFs in their portfolio for different purposes. It makes sense if you look at the various schemes and how different they are in terms of what they need, for example from a risk point of view what they need to built up. Are their members older or are they a fairly new scheme? Do they need a highly daily liquidity? It all makes a difference," he says.
ETFs are also a useful way to diversify assets, if the providers are to be believed. It is an easy tool to offset against your main assets and enter markets which normally would stay uncovered. "We see many using ETFs for tactical positions. This has certainly increased, in terms of product usage and in terms of overall usage," says Hein. "The liquidity of an ETF allows the pension scheme to quickly access any particular market and easily adjust an exposure throughout the holding period."
"Physical ETFs are flexible," says Thijssen. "They can be transferred like stocks and bonds into other portfolios when needed and that flexibility is a very important feature for pension schemes."
azeevalkink@wilmington.co.uk
First published 07.04.2011
